Bu-lat-lat (boo-lat-lat) verb: to search, probe, investigate, inquire; to unearth facts
Volume 2, Number 25 July 28 - August 3, 2002 Quezon City, Philippines
A Boost that Goes Nowhere
The United States is in the midst of a recession that may well turn out to be the worst in 20 years, and the Republican-backed stimulus package will do little to improve the economy -- indeed it may make matters worse. In the short term, unemployment will continue to rise and output will fall. But the U.S. economy will eventually bounce back -- perhaps in a year or two. More worrying is the threat a prolonged U.S. recession poses to the rest of the world.
we see inklings of the downward spiral that was part of the Great Depression of
1929: Recession in Japan and parts of East Asia and bare growth in Europe are
contributing to and aggravating the U.S. downturn.
countries stand to lose the most. Globalization has been sold to people in the
developing world as a promise of unbounded prosperity -- or at least more
prosperity than they have ever seen. Now the developing world, especially Latin
America, will see the darker side of its links to the U.S. economy. It used to
be said that when America sneezed, Mexico caught a cold. Now, when America
sneezes, much of the world catches cold. And according to recent data, America
is not just sneezing, it has a bad case of the flu.
unemployment figures show the largest monthly increase in two decades. The gap
between the United States's potential gross domestic product -- what it would be
if we had been able to maintain an unemployment rate of around 4 percent -- and
what is actually being produced is enormous. By my calculations, it is upwards
of $350 billion a year! This is an enormous waste of resources, a waste we can
is widely held that every expansion has within it the seeds of its own
destruction -- and that the greater the excesses, the worse the downturn. The
Great Boom of the 1990s had marked excesses. Irrational optimism has been
followed by an almost equally irrational pessimism. Consumer confidence is at
its lowest level in more than seven years. The low personal savings rate that
marked the Great Boom may put even more pressure on consumers to cut back
seemed to me that we were headed for a recession even before Sept. 11. In the
coming months we will have the numbers that make clear that we are squarely in
one now. The economic cost of the attacks went well beyond the direct loss of
property, or even the disruption to the airlines. Anxieties impede investment.
The mood of the country discourages the consumption binge that would have been
required to offset the reduction in investment.
any case, monetary policy -- the Federal Reserve's lowering of short-term
interest rates to heat up the economy -- has been vastly oversold. Monetary
policy is far more effective in reining in the economy than in stimulating it in
a downturn, a fact that is slowly becoming apparent as the economy continues to
sink despite a massive number of rate cuts; Tuesday's was the 10th this year.
Bush administration's tax cut, which was also oversold as a stimulus, is likely
to haunt the economy for years. Now the consensus is that a new stimulus package
is needed; the president has ordered Congress to have one on his desk by the end
of the month. Much of the stimulus debate has focused on the size of the
package, but that is largely beside the point. A lot of money was spent on the
Bush tax cut. But the $300 and $600 checks sent to millions of Americans were
put largely into savings accounts.
worries me now is that the new proposals -- particularly the one passed by the
Republican-controlled House -- are also likely to be ineffective. The House plan
would rely heavily on tax cuts for corporations and upper-income individuals.
The bill would put zero -- yes, zero -- into the hands of the typical family of
four with an annual income of $50,000. Giving tax relief to corporations for
past investments may pad their balance sheets but will not lead to more
investment now when we need it. Bailouts for airlines didn't stop them from
laying off workers and adding to the country's unemployment problem.
Senate Republican bill, which the administration backs, in some ways would make
things even worse by granting bigger benefits to very high earners. For
instance, the $50,000 family would still get zero, but this plan would give
$500,000 over four years to families making $5 million a year -- and much of
that after (one hopes) the economy has recovered. It directs very little money
to those who would spend it and offers few incentives for investment now.
would not be difficult to construct a program with a much bigger bang for the
unemployment insurance system is among the worst in the advanced industrial
countries; give money to people who have lost their jobs in this recession, and
it would be quickly spent.
investment tax credits also would help the economy. They are like a sale -- they
induce firms to invest now, when the economy needs it.
every downturn, states and localities have to cut back expenditures as their tax
revenues fall, and these cutbacks exacerbate the downturn. A revenue-sharing
program with the states could be put into place quickly and would prevent these
cutbacks, thus preserving vitally needed public services. Many high-return
public investments could be put into place quickly -- such as renovating our
dilapidated inner-city schools.
may all sound like partisan (Democratic) economics, but it's not. It's just
elementary economics. If you really don't think the economy needs a stimulus,
either because you think the economy is not going into a tailspin or
because you think monetary policy will do the trick, only then would you risk a
minimal-stimulus package of the kind the Republicans have crafted in both the
House and Senate.
what matters is not just how I or other economists see this: It matters how
markets, both here and abroad, see things. The fact that medium- and long-term
bond rates (that is, bonds that reach maturity in five or 10 years or more) have
not come down in tandem with short-term rates is not a good sign. Nor is the
possibility that the interest rates some firms pay for borrowing for plant and
equipment may actually have increased.
1993, a plan of tax increases and expenditure cuts that were phased in over
time, providing reassurances to the market that future deficits would be lower,
led to lower long-term interest rates. It should come as no surprise, then, that
the Bush package, with its tax decreases and expenditure--increases, would do
exactly the opposite. The Federal Reserve controls the short-term interest rates
-- not the medium- and long-term ones that firms pay when they borrow money to
invest, or that consumers pay when they borrow to buy a house, which are still
far higher than the short-term rate, which now stands at its lowest level in 40
years. Whatever monetary policy does in lowering short-term rates can be largely
undone by an administration's misguided fiscal policy, which can increase that
gap between short and long rates; that gap has widened considerably.
still, America has become dependent on borrowing from abroad to finance our huge
trade deficits; and the reduction in the surplus is likely to exacerbate this
(on average, the two move together). If foreigners become even less confident in
America, they will shift their portfolio balance, putting more of the money
elsewhere. That adjustment process itself could put strain on the U.S. economy.
Before the terrorist attacks, confidence abroad in America and the American
economy had eroded, with the bursting of the stock and dot-com bubbles. The two
remaining pillars of strength were the quality of our economic management and
our seeming safety. Both of these have now been questioned -- and the stimulus
package likely to become law has nothing to allay foreigners' fears.
a former White House and then World Bank official, I have had the good (or bad)
fortune to watch downturns and recessions around the world. Two features are
standard economic models perform particularly badly at such times; they almost
always underestimate the magnitude of the downturn. One relies on these models
only at one's peril. The International Monetary Fund and the U.S. Treasury badly
underestimated the magnitude of the Asian downturns of 1997 -- and this mistake
was at least partly responsible for the disastrous IMF policies prescribed in
Indonesia, Thailand and elsewhere.
there are long lags and irreversibilities: Once it is clear that the downturn is
deep, and a stronger dose of medicine is administered, it takes six months to a
year for the effects to be fully felt. Meanwhile, the consequences can be
severe. The bankrupt firms do not become unbankrupt and start functioning again.
are likely to be particularly severe when the economy is hit by a series of
adverse shocks. Market economies such as ours are remarkably robust. They can
withstand a shock or two. But even before terrorism came ashore, America had
been hit badly.The attacks added political uncertainty to the already great
here we are, facing a major downward spiral. This is where eroding confidence in
economic management comes into play. John Maynard Keynes, the founder of modern
macroeconomics, (including the notion of the stimulus) emphasized the importance
and vagaries of investors' "animal spirits" -- that is, the
unpredictability of their optimism and pessimism. But expectations, rational or
irrational, about the future are of no less importance to consumers. Those who
are worried about losing their jobs are more likely to cut back on their
spending and to save the proceeds from any tax cuts.
was great fun being part of the Great Expansion. Every week brought new records
-- the lowest unemployment rate in a quarter-century, the lowest inflation rate
in two decades, the lowest misery index in three. The good news fed on itself,
and the confidence helped fuel the expansion. We took credit where we could, but
I knew that much of this was good luck -- and the Clinton administration and Fed
not messing things up.
every week brings new records in the other direction -- the largest increase in
unemployment and decline in manufacturing in two decades, the first quarterly
fall in consumer prices in nearly a half-century, the slowest growth in nominal
GDP in any two consecutive years since the 1930s. Americans love records, but
unfortunately, these new ones are contributing to the already pervasive sense of
anxiety. The Bush administration will not try to claim credit for these new
records; rather, it will blame Sept. 11. Osama bin Laden is a convenient excuse,
but the data will show his murderous henchmen were aiding and abetting at best:
The economy was already sliding toward recession.
wish I could be more optimistic about our economy's prospect. I worry that all
of this naysaying will simply contribute to the downturn. Perhaps I am wrong,
and the economy will, on its own, recover quickly.
perhaps I am right. Then, without an effective stimulus, the U.S. economy will
sink deeper into recession, and the rest of the world with it. An ineffective
stimulus could be even worse: It would harm budgetary prospects, raising medium-
and long-term interest rates. And when we see the false claims for what they
are, confidence in our economy and in our economic management will deteriorate
further. We have had a first dose of this particular medicine. We hardly need
Stiglitz was awarded the Nobel Prize in Economics last month. A professor at
Columbia University, he was chairman of the Council of Economic Advisers from
1995 to 1997 and chief economist of the World Bank from 1997 to 2000.)